The US market has naturally been the centre of attention for investors in recent years due to its strong returns, but the tide is turning. The best gains so far in 2025 have come from a region that’s been royally unloved.

Germany generated a 13.1% total return between 1 January and 14 February 2025, more than three times that of the S&P 500 (4.1%) or the Nasdaq (3.7%) in the US.

Admittedly, that’s a brief period in which to assess performance, but it’s unusual for Germany to outperform in such a way.

The country’s main index, the DAX, has enjoyed an impressive run so far this year, with 34 of its 40 constituents delivering positive returns.

Importantly, the top gains have been broad-based and not concentrated on one sector – for example, companies in the banking, building materials, retail, chemical and tech sectors have all done well.

The US market is undoubtedly looking expensive, and investors have been giving the thumbs-down to big names reporting in recent weeks including negative reactions to results from big tech companies which have previously generated supersized returns for shareholders.

In contrast, big names on the DAX are having their moment in the sun because they are cheap and the news flow has been positive.

Investors looking to diversify their risk and potentially allocate money away from the US will naturally look for value opportunities and upbeat narratives, and Germany has much to offer – the DAX is trading on 13.9 times forward earnings versus 19.5 times for the S&P 500.

In Bank of America’s latest monthly poll of fund managers across Europe, Germany was singled out as the most preferred region from an investment perspective, which may explain the market’s year-to-date gain of 13.1%, twice the average 7.7% annual return achieved between 2014 and 2024.

That’s a blockbuster performance across a mere six weeks – only twice in the last decade has the index made double-digit gains between the start of January and mid-February, in 2023 (10.5%) and 2015 (11.8%).

The MDAX mid-cap index has also had its best start to the year since 2023 with an 8.1% return and its second-best start since 2019.

Star performers include chemicals group Lanxess (LXS:ETR), infrastructure services expert Hochtief (HOT:ETR), construction software provider Nemetschek (NEM:ETR) and engineer ThyssenKrupp (TKA:ETR).

GERMANY VERSUS THE UK

There are similarities between Germany and the UK from an investment perspective. The UK saw a new government last year and Germany has now followed suit, while both countries have a considerable challenge to accelerate economic growth and the journey won’t be easy.

Germany and the UK also share a common trait with regard to the make-up of their main stock market index, namely that constituents of the DAX and FTSE 100 generate the bulk of their earnings in foreign countries.

That suggests anticipation around the outcome of the German general election has not been the key driver for the index’s performance this year.

In fact, one stock has led the DAX over the past year and a bit, and that’s SAP (SAP:ETR), whose share price has doubled since January 2024 thanks to the AI boom.

SAP is the world’s largest vendor of ERP (enterprise resource planning) software and the company believes its AI systems can save companies big money by boosting productivity.

Last October, SAP became Europe’s most valuable tech stock, leapfrogging past chip equipment maker ASML as upbeat forward guidance for earnings fuelled its share-price rally.

KEY RISK FOR SAP

SAP trades on 42.7 times 12-months forward forecast earnings, a premium rating versus the relative cheapness of the DAX.

That poses a slight issue, as stocks on premium ratings have to keep beating estimates to justify trading on a high multiple of earnings.

Simply meeting expectations may not be enough to sustain the share price momentum and should the news flow fail to impress SAP shares could suffer a setback.

Given SAP plays such a dominant role in the make-up of the index, its success has made the market hostage to its fortune.

The DAX only contains 40 stocks, making it more than twice as concentrated as the FTSE 100, but at least it has a diverse range of sectors, unlike the Nasdaq in the US where technology dominates.

Any setback by one of the Nasdaq’s biggest tech constituents could cause a negative read-across to the whole index, whereas if SAP has a bad day, it shouldn’t drag down the telecom, automobile and financial stocks which also populate the top end of the index.

DOMESTIC CATALYSTS

Despite the DAX having more of an international flavour than you might expect, what’s going on domestically can still influence sentiment towards the index. The potential for fiscal stimulus in Germany and the ECB cutting interest rates could be positive share price catalysts.

There is always the potential for near-term volatility when there is a change in government, and the results of Germany’s general election and what it means for the country was still a live issue at the time of writing.

However, Germany’s stock market performance over the past two years has been impressive and investors who had written off the country as a source of positive returns should think again.